Best of BiggerPockets Money: Ben Felix on the 4% Rule

Mindy Jensen (0:00)

How much do you really need to retire? And is the 4% rule still safe for early retirees? In this Most Listened To episode, Ben Felix breaks down portfolio risk, flexible spending, and why a lower withdrawal rate may make sense. Listen to episode 746 to catch the rest of the conversation.

Scott Trench (0:24)

You know, there's a couple of conflicting opinions, but there are several answers that seem to be accepted and correct for an end-state portfolio. I'd love to hear one of those from you. Like, what is a portfolio that's suitable for withdrawal versus accumulation?

But what I think is really missing is this gray zone in the middle, right? So I'm approaching my FIRE number or I want to preserve financial independence and I'm still working. How do I think about my portfolio in that context? So could you help us walk through how you would think about those portfolios in the decumulation phase or approaching retirement or sustaining a level of financial independence while continuing to work?

Ben Felix (1:02)

It's complicated, is the very short answer. There are so many different things that are going to play into that decision. Really talking about the mix between stocks and bonds, right? Those are the big asset classes. Stocks have higher expected returns.

They are historically much more likely to at least keep pace with and exceed inflation over very long periods of time.

Bonds, in particular, nominal bonds, which in the US, you do have tips, which are inflation protected bonds.

In Canada, we have real return bonds, but that market is becoming thinner because our government has actually discontinued the real return bond program. Anyway, nominal bonds means bonds that are not adjusted for inflation. Those have historically, if you look around the world, been pretty risky in real terms. Like the probability of losing money in nominal bonds for a long period of time is actually pretty high. For very long-term investors, which we're talking about, fire folks, of course they will be. If you're retiring at 30 or 40, your time horizon is enormous. I do think that there are risks to at least nominal bonds. Inflation protected bonds can solve some of the problems, but they're not perfect either, especially at really, really long horizons. A lot of it comes down to the individual's preferences, their psychological ability to take risk is one big constraint. So if I said 100% equity portfolios make sense, and someone said, well, last time the market dropped 20%, I sold everything and didn't get back in the market for six years, they probably shouldn't be in a 100% equity portfolio. We do have on our website, and I can give you guys a link, a tool for psychological risk profiling. So it's like, I think it's 31 questions that people can go through, and it spits out their sort of range of stock bond mixes that make sense based on their psychological profile. And it also gives a bunch of other cool pieces of feedback, like about overconfidence and other little psychological traits. Anyway, it's a neat tool. So I think stuff like that, and that's meant to be a predictive tool about how you will react in a major market downturn. So I think that's one big input, because if people are in portfolios that are too risky for them in terms of volatility, that can be disastrous, right? If they end up bailing out of the market. I think people hear stuff like that, and they're like, well, no, I wouldn't do that. I wouldn't do that when the market crashes. But you have to remember when the market crashes, it's crashing for a reason, and that reason is usually some very scary thing. Like if we look at the COVID market crash, markets dropped a ton, and it looked like the world was ending, and we didn't know when things were gonna go back to normal and all that kind of stuff. So I think that narrative that accompanies market declines is a really important piece of understanding psychological risk tolerance. It's never just, oh, the market's down 20%.

It's, the market's down 20% because of this terrible thing that's happening, and we don't know how much further things are going to go down before they get better, if they're gonna get better at all. Anyway, all I had to say, big constraint is the psychological piece. Another piece is capacity to take risk. If somebody has whatever, a million dollar portfolio, and they need to spend $700,000 to buy a house next year, they can't take very much risk with those assets. On the other hand, if someone's spending 3% a year on a portfolio, they can take quite a bit of risk. That's another big consideration. I think with equity portfolios, particularly for any retiree, but for early retirees, I know it gets talked about a lot, people worry about sequence of returns risk. So if you get a bunch of bad years of returns in a row and you're spending from your portfolio, you can run out of money a lot sooner than you hoped. Analysis like the 4% rule is designed around finding the spending rate at which you would not have run out of money, even in the worst cases in US stock market history, with a stock and bond portfolio in the original analysis. And that's fine, but I like to reframe sequence of returns risk as sequence of withdrawals risk, because no one's forcing you to continue taking inflation index withdrawals from your portfolio every year, regardless of what's happening in the market. And I do think that flexibility in spending is a really good way to mitigate sequence of returns risk. If the market drops a whole bunch, you can spend a little bit less. That also allows you to take more equity risk in your portfolio without worrying so much about running out of money if things go poorly for a bit.